How to choose right tax-saving investment options to save income tax However, in a rush to complete the tax saving investment, we might make some mistakes. Every tax saving option must be evaluated on certain parameters before arriving at the preferred option. Read on to know things to keep in mind to choose the right tax saving investment option
The last date to complete the tax-saving exercise is fast approaching. With the rush on to make the investments on or before March 31, 2023, it is important to choose the right investment option that can save income tax. If an individual chooses an unsuitable tax-saving option, he will be stuck with it and may also lose money in the process.Adhil Shetty, CEO, Bankbazaar.com, says, "Choosing the right tax-saving option depends on several factors, including your income level, risk appetite and investment goals."
Every tax saving investment option must be evaluated on certain parameters to ascertain if it is the right option for you or not. These parameters can be classified as returns, safety, liquidity, holding period, alignment to the life goal and taxation. An investment option that scores higher on all of these can be considered a good tax-saving option.
For example, interest and maturity from Public Provident Fund (PPF) is tax exempt. However, PPF comes with a lock-in period of 15 years, which limits liquidity. Such a long period may work for some people for some life goals but not for all.
The National Savings Certificate (NSC) or a 5-year tax-saving fixed deposit (with a bank or post office) also comes with a lock-in of 5 years. Again, there is no liquidity here and the interest earned is taxable. As the holding period is not very long, many investors may be fine with the lock-in period of 5 years to get a tax benefit.
Equity linked savings scheme (ELSS) mutual funds have the shortest lock-in period of three years and the taxation of capital gains is at special rates, i.e., 10% without indexation. However, ELSS schemes invest in equity shares and are considered riskier than other tax-saving options. Further, there is no premature withdrawal facility during the three years of lock in.
Though individuals will save tax by investing in some of these avenues, they might end up paying higher tax on returns or interest earned if the returns are not tax free. In such cases, the post-tax returns will be diminished. For instance, a tax-saving fixed deposit (FD) offering 7% interest will actually give 4.81% after deducting tax at the 30% rate and calculating cess. This is why many individuals prefer an investment with tax-free return or investment options where the post-tax return is not diminished.
There are several tax-saving investment options and each option has its own advantages and disadvantages, and you need to evaluate them based on your investment goals and risk appetite.
Shetty lists some of the questions you have to answer while selecting a tax-saving product: Are you looking for short-term or long-term investment options; what is your risk appetite; do you prefer fixed income or equity investments?
An individual must also see if the tax-saving option suits the investment plan. Dev Ashish, a SEBI-registered investment advisor and founder of Stableinvestor.com, says, "Choosing the right tax-saving option means fitting it into your overall financial planning."
Ashish advises individuals to consider four points before selecting an option. These are:
a) Life insurance: Adequate financial protection for your dependents is first step of your investment. Check if you have adequate life insurance. If not, get yourself a term life plan that offers higher life insurance cover at the least cost. The premiums will be eligible for Section 80C benefits. Just for tax saving, many people end up buying investment cum life insurance plans such as traditional endowment or money-back plans. These plans neither provide large life insurance cover nor good returns. These are best avoided unless you are an ultra-conservative saver. ULIPs (Unit linked insurance plans) offered by insurance companies give you market linked return which can work well for long term goals. However, you have to make sure you go for only those ULIPs which have minimised their cost and are comparable to MF in terms of fund management charges.
b) Voluntary Provident Fund (VPF) or PPF: If your long-term investment portfolio for life goals like retirement is made up majorly of debt instruments - like PPF and Employees' Provident Fund - you can use ELSS funds to increase equity exposure and save some taxes. But if you are already investing in equity funds heavily and your PF corpus is comparatively smaller, increase your VPF contribution to save tax, in addition to bulking up your provident fund corpus. If VPF is not available, contribute up to Rs 1.5 lakh to your PPF account. The returns on EPF and PPF are known to be one of the highest among the safest fixed income investment options. The returns are also tax free.
c) ELSS: These are meant for your mid to long term life goals. Remember that all ELSS funds are not alike. Some are large-cap oriented and others are mid-small cap oriented. So, if you already have a few equity funds in your portfolio, pick an ELSS fund that fits well with them based on what overall allocation you want to the market cap segments. Don't just blindly pick the highest star-rated or table-topper ELSS fund each year. And, yes, you don't need to choose a new ELSS fund each year. Long term capital gains up to Rs 1 lakh on ELSS are exempted from income tax in any financial year. To garner a gain of Rs 1 lakh or above on an investment of Rs 1.5 lakh could happen very rarely. So, if you exit after 3 years lock-in it is more likely that your entire gain may be tax exempted.
d) NPS: Having adequate retirement corpus, which can support post retirement life well, is one the biggest challenge for most individuals. Every possible investment avenue can help you reach closer to your desire corpus. NPS offer such an opportunity. Your investment in National Pension System (NPS) to Rs 50,000 a year get additional tax benefits under 80CCD (1B). NPS is a retirement-only product, is illiquid till your late 50s and cannot be used for other goals. But for some, it might still make sense when planning for retirement. That way, they can get additional tax benefits as well. The return earned on NPS investment will be tax exempted however you will get only up to 60% of your corpus as lump sum at the time of retirement and you would need to purchase an annuity plan with remaining 40% of the corpus. This annuity income will be taxable.
Shetty says, "Many taxpayers need just three tax savings options. First is health insurance, second is term insurance, and third is for those who want to save tax and maximise their returns - ELSS, also known as tax-saving mutual funds. If you are averse to risky investment, you can opt for EPF or PPF, whichever suits your financial goals. Another popular option is the NPS. Evaluate your options to make an informed decision."
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This story originally appeared on: India Times - Author:Faqs of Insurances
